One of the primary reasons for being an owner of self-directed Individual Retirement Account (“SDIRA”) is access to alternative investments. Alternative investments are generally viewed as investments that are “non-Wall Street” types of investments. They include, without limitations, real estate, cryptocurrency, private equity, venture capital, and others, which are generally not tied to the stock market. Many of these investments are offered through what is called “Private Placements” or “Private Offerings.”
However, in these alternative investments, as an owner of a SDIRA, you may come across this question: “Are you an accredited investor?” There are nuances and legal ramifications you should be aware of as to the definition of an “accredited investor.”
Private Placements:
Before we dig into the definition of Accredited Investor, we should know what is a private placement or private offering. There are various types of private offerings, which includes Rule 504, 505, and 506 offerings under Regulation D, Crowdfunding offerings, and intrastate offerings under Reg 147. These private offerings are “private” because they are exempt from registration with the SEC.
One of the most popular and commonly used exemptions in private placements are Rule 506 offerings under Regulation D. This is primarily because the issuer can raise money on an unlimited basis. Since the Jumpstart Our Business Act (“JOBS Act”), Rule 506 has been amended with a split into two commonly used exemptions: Rule 506(c) and 506(b).
Under Rule 506(c), the issuer can raise unlimited amounts of money with the ability to advertise to the public, provided that, the issuer also verifies whether you, as the investor, are an accredited investor. Under Rule 506(b), the issuer can still raise unlimited amounts of money, but the issuer cannot advertise to the public. You, the investor, must have a pre-existing relationship with the issuer, and must be either an accredited investor or one of 35 non-accredited, yet sophisticated investors. However, for 506(b), the issuer is not required to verify whether you are an accredited investor.
What is an Accredited Investor?
The Securities and Exchange Commission (“SEC”) defines Accredited Investor under Regulation D, Rule 501 of the Securities Act. There are many examples of what the SEC defines as an accredited investor, but on a simplistic and relevant basis, can be summarized, as follows:
- If you are investing as an individual, you must have either (1) income that meets or surpasses threshold amount; or (2) have sufficient assets. More specifically,
- If you are single, your income must be at least $200,000 for the previous two years with the reasonable expectation that your level of income will continue; or (2) If you are married, $300,000 combined with your spouse with the same reasonable expectation that the level of combined income will continue; or
- your personal net worth is $1 million or more (excluding your primary residence)
- If you are investing as an entity (i.e., trust, limited liability company, corporation, or others), the investing entity must have at least $5,000,000 in assets.
Please refer to 17 C.F.R. § 230.501 for the complete definition of an accredited investor.
What is the Issue of being an Accredited Investor?
As an accredited investor (or one of the 35 non-accredited investors for Rule 506(b) investments), you may invest in private placements and take advantage of alternative investments, such as real estate, private equity, and others by using SDIRAs. This provides a wide array of other types of investments the general public may not be able to access.
How does an Issuer Verify Accredited Investor Status?
Rule 506(c) requires the issuer to verify your status as an accredited investor. The issuer generally conducts verification in three ways:
- Self-verification: the issuer requests various information and/or documentation to verify your status. This documentation may include financial statements, pay-stubs, bank account statements, or other similar documents.
- Third-party verification: the issuer may rely upon a third-party service, including a certified public accountant or an attorney, who has intimate knowledge of your financial circumstances. The third-party may provide a letter indicating you are an accredited investor.
- Other services: the issuer may ask that you use a third-party website, such as verifyinvestors.com, to verify your accredited investor status.
Other Exemptions
The SEC and state regulators recognize the public may want to invest more directly without going through private placements. The regulators are primarily concerned about fraud. In a private offering, risks are generally higher, not only on the types of investments available and the lack of liquidity, but also because there is extremely limited information available about these private offerings. Prior to investing, confirm whether the company has updated and proper filings, and has appropriate documentation. One way to confirm prior to investing is through the Edgar search website from the SEC. This database contains private offerings filed with the SEC.
However, you may want to invest in a specific real property on a joint venture basis with your friends and/or family members. Regulators recognize these types of transactions and may provide an exemption to conduct this type of business. Individual states likely have an exemption for this type of transaction. For example, in California, you may invest with your friends and family members under California Corporations Code 25102(f). In this instance, none of the investors must be accredited investors, but must have a pre-existing relationship, and include no more than 35 investors. Other states will likely have similar exemptions.
Conclusion:
The world of alternative investments is exciting. However, investors must be cognizant of certain aspects of private offerings. Limited information (i.e., lack of transparency), along with low liquidity (meaning that you may not withdraw or redeem your investments until at minimum of 1 year) are some of the major factors he or she must take into consideration. To be sure, you do not have to be an accredited investor to invest in alternative investments by ways of SDIRA. Each investment vehicle, whether through private placement or other exempt offerings, are available for investments, including those mentioned above.
Tae Kim is a Corporate and Securities Attorney at Geraci LLP whose practice involves advising clients on securities compliance in private and public offerings, fund designing, and preparing offering documents. Tae and the Corporate and Securities team work closely with clients to establish mortgage funds, real estate acquisition funds, syndications, real estate investment trusts (REITs), and Qualified Opportunity Funds. Tae can be reached at 949-379-2600 or at t.kim@geracillp.com.
*Mainstar's role as custodian of self-directed accounts is nondiscretionary and/or administrative in nature. This information is for educational purposes only, and should not be construed as investment, legal, tax or financial advice or as a guarantee, endorsement, or certification of any investments. Mainstar encourages individuals to consult a financial or legal professional when making investment decisions.